The Economic Consequences of a War with Iraq
Figure 1. Oil Prices in the "Worse" and "Happy" Scenarios
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- Size of Defense Buildup in Past Conflicts
- Major Factors Determining Short Run Economic Behavior After the Beginning of the first Persian Gulf War
- Summary of Economic Costs
- Why Do Nations Underestimate the Costs of War
- Another Chapter in the March of Folly
Figure 1. Oil Prices in the "Worse" and "Happy" Scenarios Source: See Appendix. __________________________________________________________________ Macroeconomic Impacts Historically, economic expansions were the constant companions of war. Indeed, a standard exam question in intermediate economics was, “Marxists claim that war is necessary for full employment? True or False?” The reason for the iron law of wartime booms can be seen in Table 6. In World War II, for example, defense outlays rose by almost 10 percent of total GDP before Pearl Harbor, and this spending boosted the economy out of the doldrums of the Great Depression. Similar but smaller military buildups accompanied the economic expansions in the Korean and Vietnam Wars. The iron law of wartime booms ended with the first Persian Gulf War. One of the reasons why the iron law of wartime booms has been repealed can also be seen in Table 6: defense spending during the First Persian Gulf War increases by only 0.3 percent of GDP. Because the public sector provided no expansionary impetus, the course of macroeconomic activity was determine by the private sector, which in turn was driven in the short run by psychological reactions to the war. The major psychological factors that affect the economy in the short run are those driving stock prices, exchange rates, and consumer sentiment. Sharp drops in consumer sentiment and stock prices tend to depress consumer spending, particularly on consumer durables, and business investment. Sharp declines in the dollar tend to raise inflation and are sometimes associated with declines in asset prices. Figure 2 shows the dramatic psychoeconomic reaction to the Iraqi invasion of Kuwait in August 1990. The figure shows indexes of consumer sentiment, stock prices, the exchange rate of the dollar, and industrial production, where I have normalized each variable to equal 1 in July 1990 (the month before the invasion). Consumer sentiment and the stock market both took a sharp nosedive after the initial Iraqi invasion. They then recovered sharply with the quick U.S. victory in February 1991. Industrial production reacted gradually to the resulting decrease in demand. The recession was sharp, and, notwithstanding the general euphoria after the 100-hours war (seen in the upturn in consumer sentiment), the recovery was slow. The total shortfall of GDP relative to its potential from the beginning of the war until the end of 1991 was around $250 billion (in 2002 prices). 
Table 6. Size of Defense Buildup in Past Conflicts Source: Department of Commerce, National Income and Product Accounts, available at www.bea.gov . ____________________________________________________________ 
Figure 2. Major Factors Determining Short Run Economic Behavior After the Beginning of the first Persian Gulf War Source: Data from the U.S. Department of Commerce, Federal Reserve Board, Standard and Poor’s Corporation, and the University of Michigan. _______________________________________________________ The increase in defense spending over the last year (2001:2 through 2002:2) was only 0.3 percent of GDP, so it is likely that psychological factors again will dominate the macroeconomic response to the Second Persian Gulf War unless the conflict spirals outwards from Iraq. A repetition of the 1990-91 downturn is unlikely because markets have in part discounted the prospect of a war, or at least of a short war. Since summer 2002, stock prices have fallen 20 percent, the dollar has depreciated, and indexes of consumer sentiment are at their lowest level for almost a decade. Fears of war are hard to separate from the weak economy, corporate scandals, and poor profits, but part of any adverse psychological reaction to a short war has probably already occurred. In the case of a quick and relatively bloodless victory, the macroeconomic impact is likely to be nil to favorable. If the war goes badly in the initial phases, the macroeconomic outcome might turn negative. The dangers of tipping into recession are real, particularly given that the U.S. economy was growing very slowly in summer 2002. If there is some combination of heavy casualties, protracted urban warfare, gory pictures on the nightly news, massive foreign denunciations of American policy, rumors or reality of chemical or biological weapons, or major terrorist actions at home or abroad, the economic reactions might resemble the sharp economic declines following the 1990-91 war or the sharp drop in economic activity following 9/11. A plausible unfavorable outcome would be that the economy would experience an average recession in the wake of the war, with output losses in the range of 2 to 5 percent of GDP ($200 to $500 billion in today’s dollars). A prolonged conflict is likely to have more profound macroeconomic consequences on the budget and private spending. However, standard macroeconomics holds that the pure cyclical impacts on output and unemployment can over the medium run be offset through monetary and fiscal policy, and I see no reason to think that the standard view is wrong in the current circumstances. Summary of Economic Costs We can now collate the different components of the cost of a war with Iraq. It should be emphasized that these estimates vary in terms of precision and empirical support. Indeed, aside from the estimates of the direct military costs, all of the numbers should be regarded as informed conjecture. Moreover, these costs do not attempt to estimate the benefits of resorting to arms. Since reducing future dangers from a continuation of the Hussein regime are one of the major objectives of the war, we cannot truly balance the costs and benefits of war without considering the benefits of the disarmament of Iraq. The point was clearly put by Secretary Powell when he asked, “But do we want Saddam Hussein to have nuclear, chemical and biological weapons that he can use, as he has used these kinds of weapons in the past against his neighbors, against his own people, or perhaps against us someday? This is the time to stop him.”42 We do not (and cannot) measure the extent to which military action today may reduce the threat of Iraqi weapons of mass destruction in the future. At the same time, we also do not and cannot estimate the increase in risk of terrorist or other costly actions which are triggered by a war or that are not prevented because U.S. attention is focused on Iraq. Table 7 shows a summary compilation of the different elements that we have been able to quantify. Recall that these costs include only the costs to the United States and exclude any costs to foes and friends. The favorable case in the first column of numbers indicates that the economic costs are relatively modest, in the order of $120 billion dollars. (These are the total costs over the next decade, not the annual figures.) This outcome assumes that the military, diplomatic, and nation-building campaigns are successful.  Notes:
[1] Protracted conflict assumes that the monthly cost is 50 percent greater than the CBO estimate and combat lasts 8 months longer. This yields $7.5 x 1.5 x 8 = $90 billion additional costs. [2] The low and high numbers assume, respectively, peacekeeper costs of $200,000 to $250,000 per peacekeeper per year, with the numbers from 75,000 to 200,000, and for periods of 5 to 10 years. [3] This includes, at the low end, reconstruction costs of $25 billion and minimal nation-building costs. At the high end, it adds a “Marshall Plan for Iraq” as described in the text. [4] The high estimate is equivalent to 1½ years of Perry's “worse” or middle case, while the worst case would be almost twice as high. The low-cost case assumes that Iraq increases production by 1 mbpd in the five years after the end of hostilities. The sign is negative to indicate a benefit or negative cost. Conceptually, these figures include only the impact of oil price changes (the terms of trade effect) and exclude the macroeconomic impacts. [5] The high cost assumes that the impact is the same as the estimated impact of the First Persian Gulf War scaled to 2002 GDP. This excludes the terms of trade effects that are calculated in the impacts on oil markets in [4]. The unfavorable case is a collage of potential unfavorable outcomes rather than a single scenario. It shows the array of costs that might be incurred if the war drags on, occupation is lengthy, nation building is costly, the war destroys a large part of Iraq’s oil infrastructure, there is lingering military and political resistance to U.S. occupation in the Islamic world, and there are major adverse psychological reactions to the conflict. The outer limit of costs would be around $1.6 trillion, most of which come outside of the direct military costs. Be warned that this discussion vastly oversimplifies the analysis by constructing only two cases, whereas reality presents a dizzying array of outcomes. Returning to the metaphor of war as a giant roll of the dice, we might say that the U.S. could end up paying the “low” costs of around $120 billion if the dice come up favorably. If some dice come up unfavorably, the costs would lie between the low and the high cases. However, if the U.S. has a string of bad luck or misjudgments during or after the war, the outcome, while less likely, could reach the $1.6 trillion of the high case. Even the high case is not the limit of fortune’s frowns. These estimates exclude any costs to other countries, omit the most extreme outcomes (such as chemical or biological warfare), and exclude Perry’s “worst” case in oil markets. Moreover, the quantified costs ignore any tangible or intangible fallout that comes from worldwide reaction against perceived American disregard for the lives and property of others. One feature of the costs not shown in Table 7 is the extent to which other countries share the costs. In the first Persian Gulf War, the U.S. diplomatic efforts reduced the domestic cost of the war essentially to zero. It seems highly unlikely that the U.S. can transfer most of the costs to other countries in the present circumstance, and help from U.S. allies is even more unlikely if the U.S. undertakes a unilateral war by preemption. Indeed, the longer, more expensive, bloodier, more unilateral, and more destructive is the war, the larger the fraction of the very large costs the U.S. will be forced to bear. Why Do Nations Underestimate the Costs of War? The historical record is littered with failed forecasts about the economic, political, and military outcomes of wars. It can hardly be a surprise that forecasts about the costs of wars were so far of the mark. When wars occur, this is evidence of some kind of major miscalculation or impaired collective decision-making on a grand scale. With hindsight, would the southerners have gone to civil war if they had known the devastation that would follow? Would the Germans have provoked World Wars I and II? Would Japan have bombed Pearl Harbor? Would the United States have engaged half a million men in Vietnam? The history of war is, as Barbara Tuchman entitled her insightful book, the march of folly. Are there structural reasons why nations underestimate the costs of war? To some extent, the answer to this question is plagued by selection bias. Just as 90 percent of legal disputes are settled before they reach the courthouse, similarly a large fraction of disputes between nations are resolved without a resort to arms. Wars are disproportionately fought by those – like Saddam Hussein – who cannot count, refuse to count, count badly, or belittle costs. Sometimes, as with Lyndon Johnson, leaders pursue war because they get foolishly sucked into a psychology where honor and credibility are valued above the lives of combatants and the livelihoods of citizens. Citizens should demand a careful accounting because they, not Presidents or Senators, pay the bills and send their children into battle A second reason why nations underestimate combat’s cost is that they are unable to listen or are provided systematically biased information. Some leaders either cannot hear bad news or kill the messenger who delivers it. Philip II of Spain was of the first variety, as Tuchman recounts: Wooden-headedness, the source of self-deception, is a factor that plays a remarkably large role in government. It consists in assessing a situation in terms of preconceived fixed notions while ignoring or rejecting any contrary signs. It is acting according to wish while not allowing oneself to be deflected by the facts. It is epitomized in a historian’s statement about Philip II of Spain, the surpassing wooden-head of all sovereigns: “No experience of the failure of his policy could shake his belief in its essential excellence.”43 There are many examples of the dangers of sealing off a leader from information in such a way that produces poor decisions. Indeed, Saddam Hussein has an unbroken record of miscalculations since his rise to power in 1989. His reign has comprised eight years of disastrous war with Iran, one year of war with the United States, eleven years of draconian sanctions, and only three years free of costly disputes or hostilities. Many today believe that Saddam Hussein’s catastrophic miscalculations were in part due to the poor and biased quality of Iraqi intelligence. An example from PGW-I is instructive: On the eve of the ground war, after more than a month of sustained air attacks, [Hussein] told Soviet envoy Yevgeny Primakov (who was trying to negotiate an Iraqi withdrawal from Kuwait), “If America decided on war it will go to war whether I withdraw from Kuwait or not. They are conspiring against us. They are targeting the leadership for assassination. What have the Iraqis lost? They might yet gain!”44 A third reason, particularly salient for democracies like the United States, is the advantage of understating costs for gaining political consensus. If wars are thought to be short, cheap, and bloodless, then it is easier to persuade the populace and the Congress to defer to the President. If the American people are led to believe that PGW-II will be like PGW-I or like the Afghanistan conflict, then they may believe that war will not disrupt life or comforts while the world will have one less tyrant. Moreover, if complications arise, it is much easier to raise the extra billions of dollars once troops are in the field and bullets are flying than before the battle is engaged. Politics does not end at the water’s edge, but it is surely silenced when the first shot is fired. Each of these causes of ignoring or underestimating the economic costs of war – the losers’ curse, wooden-headedness, and the political advantage in securing consensus – can be reduced by a careful and public discussion of the costs of war. Today’s debate about giving the President war-making powers cannot be well informed unless these costs are presented and dissected, and legislators who do not insist on a thorough analysis are leaving half of the equation unexamined and unchallenged. Another Chapter in the March of Folly? It seems likely that Americans are underestimating the economic commitment involved in a war with Iraq. This is hardly new, for the record is littered with failed forecasts about the economic, political, and military outcomes of wars. The history of war is, as Barbara Tuchman entitled her wonderful book, the march of folly.45 Is America writing another chapter in the march of folly? It is impossible to know in advance, but historians may look back at several early warning signs of economic and political miscalculations. The first concern is that the Bush administration has made no serious public estimate of the costs of the coming war. The populace and the Congress are unable to make informed judgments about the realistic costs and benefits of the upcoming conflict when none is given. Particularly worrisome is the promise of post-war occupation, reconstruction, and nation building in Iraq. If American taxpayers decline to pay the bills, this would leave a mountain of rubble and mobs of angry people in Iraq and the region. Closely related is a second syndrome, frequently found in past conflicts, of entering war prepared militarily but not economically. The finances of the nation have deteriorated sharply since George W. Bush took office. The annual federal budget has deteriorated by $360 billion in 1½ years, and, even with a short war, budget deficits are likely to mount in coming years. The Bush administration has not prepared the public for the cost or the financing of what might prove an expensive adventure. Perhaps, the administration is fearful that a candid discussion of wartime economics will give ammunition to skeptics of the war; perhaps, it frets that acknowledging the costs will endanger the large future tax cuts, which are the centerpiece of its domestic policy. Nonetheless, the price must be paid – by raising taxes, by cutting expenditures, or by forcing the Federal Reserve do the job by raising interest rates, thereby curbing investment and especially housing. One way or another, Americans will pay for the war. Third, the predisposition of the United States under the Bush administration to undertake unilateral actions poses major risks. From a military point of view, attaching without a broad coalition of countries can make the conduct of the war more difficult and costly, and it may raise the hopes of the Iraqi leadership that others will come to their aid, thereby extending the conflict. From a political point of view, unilateral actions, particularly those taken without support from the Islamic world, risk inflaming moderates, emboldening radicals, and spawning terrorists in those countries. From a legal point of view, America’s insistence on the right to overturn foreign governments without the sanction of international law will undermine a wide variety of cooperative efforts on international finance, disarmament, the environment, non-proliferation, and anti-terrorism. From an economic point of view, unilateral actions imply that the costs will be largely borne by the United States. Fourth, strategists may be deluding themselves on the reaction of the Islamic world and the Iraqi people to American intervention. A key uncertainty concerns the loyalty of Iraqi troops and the willingness of the Iraqi military commanders to undertake an urban defense of Baghdad. Furthermore, even though no major Arab government is solidly behind the United States, the administration appears to be persuaded that Muslims are just waiting for the overthrow of Saddam to dance in the streets and that Americans will be welcomed in Baghdad as liberators rather than infidels. Major blunders could unfold if both tactics prove more formidable and admiration for America less widespread than the American administration believes. Finally, one senses an obsession bordering on wooden-headedness in the Bush administration’s focus on Iraq in general and on regime change in particular. In contrast to the clear danger from terrorist activities, there is no imminent threat from Iraq. The war in Iraq threatens to claim the scarce resources and attention of the United States for many years, distracting the country from other troubling spots, like North Korea or the Israeli-Palestine conflict. The administration concentrates on Iraq, while slow growth, fiscal deficits, a crisis of corporate governance, and growing health-care problems threaten the economy at home. The domestic economy and the rest of the world will take a back seat as the U.S. deals with war and peace in Iraq. Notwithstanding all the warning signs, the administration marches ahead, heedless of the fiscal realities and undeterred by cautions from friends, allies, and foes. Soon, the United States will cry havoc and roll the dice of war. 1 H.J.Res.114 (October 2002). 2 See Table 2 below. 3 The economic story is beautifully laid out in Arthur Okun, The Political Economy of Prosperity, Brookings, Washington, D.C., 1970, Chapter 3. 4 See particularly Anthony H. Cordesman, Iraq’s Military Capabilities in 2002: A Dynamic Net Assessment, Center for Strategic and International Studies, Washington, September 2002. 5 http://www.eia.doe.gov/emeu/cabs/iraq.html 6 http://www.eia.doe.gov/emeu/cabs/iraq.html 7 Kamran Mofid, The Economic Consequences of the Gulf War, Routledge, London, 1990. 8 Abbas Alnasrawi, The Economy of Iraq, Greenwood Press, Westport, CT., 1994. 9 Sheila Carapico, “The Impact of Sanctions in Iraq,” Middle East Report, Spring 1998, vol. 28, no. 206, no. 1 (slightly edited for brevity), available at http://www.cam.ac.uk/societies/casi/info/themes.html#hum . 10 Assessing the Cost of Military Action Against Iraq: Using Desert Shield/Desert Storm as a Basis for Estimates, An Analysis by the House Budget Committee, Democratic Staff, September 23, 2002. 11 Anthony H. Cordesman, Iraq’s Military Capabilities in 2002: A Dynamic Net Assessment, Center for Strategic and International Studies, Washington, September 2002; Michael E. O’Hanlon, “Three Months to Baghdad,” The Washington Times, August 30, 2002. 12 Anthony H. Cordesman, Iraq’s Military Capabilities in 2002: A Dynamic Net Assessment, Center for Strategic and International Studies, Washington, September 2002, p. 81. 13 Ibid, pp. 7f. 14 http://www.fednet.net/archive/ and cited at http://www.smh.com.au/text/articles/2002/09/27/1032734328055.htm . 15 Id. 16 Michael E. O’Hanlon, “Counting Casualties: How many people would die in an Iraqi War?” Slate, September 25, 2002. 17 Anthony H. Cordesman, “Iraq’s Military Capabilities: Fighting A Wounded, But Dangerous, Poisonous Snake,” Center for Strategic and International Studies, December 3, 2001. 18 Cordesman, p. 45. 19 A report on a new U.S. approach to urban warfare is given in Eric Schmitt and Thom Shanker, “Threats and Responses: Military Tactics; U.S. Refines Plans For War In Cities,” New York Times, October 22, 2002, p. 1. 20 WSJ, September 15, 2002. 21 WSJ, September 15, 2002 (“Saddam’s Oil”). 22 White House Daily Briefing, September 16, 2002. 23 Assessing the Cost of Military Action Against Iraq: Using Desert Shield/Desert Storm as Basis for Estimates, An Analysis by the House Budget Committee, Democratic Staff, September 23, 2002 (hereafter, “House study”). 24 Congressional Budget Office, “Estimated Costs of a Potential Conflict with Iraq,” September 2002, available at http://www.cbo.gov/ (“CBO Report”). 25 The DNBC report also includes interest costs in the estimates. These costs are inappropriate, however, for they depend upon the financing of the war. 26 James Fallows, “A ‘Liberated’ Iraq Could End Up Like Weimar Germany,” September 24, 2002, Guardian/UK. 27 Philip H. Gordon and Michael E. O’Hanlon, “Should the War on Terrorism Target Iraq? Implementing a Bush Doctrine on Deterrence,” Brookings, Policy Brief #93, January 2002. 28 CBO Report, p. 4. 29 The low and high numbers assume, respectively, peacekeeper costs of $200,000 to $250,000 per peacekeeper per year, with the numbers from 75,000 to 200,000, and for a period of 5 to 10 years. 30 Statement Of General (Retired) Wesley K. Clark, U.S. Army, Before The House Armed Services Committee United States House Of Representatives, September 26, 2002 at http://www.house.gov/hasc/openingstatementsandpressreleases/107thcongress/02-09-26clark.html. 31 http://www.whitehouse.gov/news/releases/2002/10/20021007-8.html 32 Thomas Friedman, New York Times, September 18, 2002. 33 Marina Ottaway, Thomas Carothers, Amy Hawthorne, and Daniel Brumberg, “Democratic Mirage in the Middle East,” Policy Brief, Carnegie Endowment for International Peace no. 20, October 2002. 34 World Bank, “Afghanistan: World Bank Approach Paper,” November 2001, available at lnweb18.worldbank.org/SAR/sa.nsf/Attachments/ az/$File/afgApproach.pdf. 35 Roger D. Carstens, “A Marshal plan for Iraq,” The Washington Times, August 5, 2002. (“The solution is to provide U.S. leadership in the implementation of a Marshall plan for Iraq. An Iraq that is stable, strong and pro-American is in our interests. Both America and the people of Iraq deserve it.”) 36 Žarko Papić, “Normal Social Policy and International Humanitarian Assistance in the Conflict Context,” IBHI, Sarajevo, October 2000, available at www.stakes.fi/gaspp/seminar/papapic.pdf. 38 Frontline/BBC, “Oral History,” January 1996, available at http://www.pbs.org/wgbh/pages/frontline/gulf/oral/baker/5.html. 39 U.S. Central Intelligence Agency, “Damage Assessment - Kuwait Oil,” April 2002, available at http://www.fas.org/irp/gulf/cia/960702/70076_01.htm. 40 Anthony H. Cordesman, Iraq’s Military Capabilities in 2002: A Dynamic Net Assessment, Center for Strategic and International Studies, Washington, September 2002, p. 81. 41 Estimates from Geodesign, Ltd., available at http://www.geodesign.co.uk/iraq/iraq_why.htm. These estimates assume that the total development costs are approximately $10,000 of capital costs per mbpd. This is high relative to development costs in other Middle East countries, however. 42 Interview on the Oprah Winfrey Show, October 22, 2002, available at http://www.state.gov/secretary/rm/2002/14563.htm. 43 Barbara Tuchman, The March of Folly: From Troy to Vietnam, Knopf, New York, 1984, p. 7. 44 Cited in F. Gregory Gause, III, Iraq and the Gulf War: Decision-Making in Baghdad, available at http://www.ciaonet.org/teach/cs/gaf01.html. 45 Barbara Tuchman, The March of Folly: From Troy to Vietnam, Knopf, New York, 1984. Directory: ~nordhaus ~nordhaus -> 1 Productivity Growth and the New Economy ~nordhaus -> 1 Life After Kyoto: Alternative Approaches to Global Warming Policies Download 151.58 Kb. Share with your friends:
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